This is About Jurnal, Time Value Of Money

© All Rights Reserved

0 views

This is About Jurnal, Time Value Of Money

© All Rights Reserved

- Groupe Ariel S.A. Case Study
- Cost Engineering_ Time Value of Money - Chemical Engineering
- Chemical Process Design
- Biotech Valuation Model
- Aurora Supply
- Financial Management Case Study
- Chapter 8 Costing PDF
- 3500145 Financial Math for Actuary and Businessman
- Corp. Finance Ksi Final
- 3003308MS Sample Ms - Advanced
- Assignment1 Solution
- OceanCarriers Ken
- Discounted Cash Flow Additional Notes
- Aurora Final
- Theory on Mafa CA Final
- Mba Fam Assignment Uog
- Multilateral Well Assignment.docx
- Answer
- Cost Module
- Avik's Dream Project

You are on page 1of 5

Munteanu Irena

„Ovidius” University of Constanta

irena.munteanu@yahoo.com

Bacula Mariana

“Traian” Theoretical High School, Constanta

baculamariana@yahoo.com

Abstract

The Time Value of Money is a important concept in financial management. The Time Value of

Money (TVM) includes the concepts of future value and discounted value. It is mandatory for a

financial professional to know and operate the specific techniques of TVM. Within the present

article we present the basic notions and illustrate their application in the field of investment

projects. The case studies presented are valuable for an efficient financial management.

J.E.L. classification: G21; G32; M21

1. Introduction

The concept of Time Value of Money (TVM) has a large applicability in the financial

management of companies, in banking, on the capital market and in day to day life.

Damodaran sed: ,,There are three reasons why a dollar tomorrow is worth less than a dollar today:

Individuals prefer present consumption to future consumption. To induce people to give up

present consumption you have to offer them more in the future.

When there is monetary inflation, the value of currency decreases over time. The greater

the inflation, the greater the difference in value between a dollar today and a dollar

tomorrow.

If there is any uncertainty (risk) associated with the cash flow in the future, the less that

cash flow will be valued”. (Damodaran, 2010)

But why is TVM concept necessary in banking?

People with spare funds and the desire to invest them could decide to directly lend them to

borrowers in exchange for periodic repayments of the principal and interests. However, this

would involve resources and costs for both the lender and the borrower:

(1) On the one hand, it is extremely difficult for the lender to have an accurate picturs of the

borrower’s situation in terms of guarantee, so lender would have to monitor the borrower so as

to assess the security of the investment;

(2) On the other hand, the borrower might want a larger loan than the lender is able to provide

or perhaps needs the money for a longer period of time than the lender can afford. (Paniego,

Muñoz MLM, 2015 p 4)

The concept of TVM is used in financial management and within the selections methods of

investment projects.

The TVM is the concept according to which a sum of money owned in the present has a greater

value than the value of the same sum received at a moment in the future. Thus, it is taken into

account the opportunity of the one presently owning the sum of money to invest it and to obtain

future gains such as interest or profit. The techniques used in order to make possible comparing and

593

“Ovidius” University Annals, Economic Sciences Series

Volume XVII, Issue 2 /2017

calculating the time value of money include: Compounding, Discounting, Capitalization, Indexing.

Within the present paper we shall focus on the first two techniques.

,,In fact, most of Time Value of Money formulas are closely related. When introducing TVM

formulas, the author can classify them under different conditions and link their relationships to

organize them”. (Chen J. K, 2009, p 77)

Compounding represents the conversion of a current (today) amount of money into a future (a

future year) amount of money, through the compounding factor or the compounded interest factor.

The formula is:

V n = V o × (1 + k)n , where:

V o = the initial invested capital (the present day sum of money);

k = the profitability rate requested / expected by the investor;

n = the time interval existing between the present moment and the future moment for

which the future value of the capital is estimated

V n = the value of the capital estimated for a certain future moment;

(1+k)n = represents the compounding factor.

,,Future Value is the value at some future time of a present amount of money, or a series of

payments, evaluated at a given interest rate”. (Kuhlemeyer, 2008)

,,Discounting is the technique that calculates the present value of a future sum of money (that

can be received or paid). Discounting requires computing the discounted (present) value of the

amount of money (cash flows) that are going to be received at future moments in time.

1

V0 = Vn ×

(1 + k )n

Present Value is the current value of a future amount of money, or a series of payments, evaluated

at a given interest rate”. (Kuhlemeyer, 2008)

The evaluation of investment projects of companies is an important part of the efficient financial

management and presumes taking the following mandatory steps:

1. Quantifying the costs of the investment project is the initial deciding step, with

important effects over the next steps and over the final selection decision.

2. Estimating the cash flows (CF) that will result following the implementation of the

investment project.

3. Determining the cost of capital or the discount rate

4. Discounting the cash flow generated by the exploitation of the investment.

5. Comparing the present value of the estimated cash flows with the prior computed costs

of the project. If the present discounted value of cash flows of the respective project is larger than

the implementation costs, then the project may be accepted as being profitable. Otherwise, the

project is not to be implemented.

In order to select the profitable investment projects we can use the payback period (PP)

method or the NPV (net present value) method.

are two options to make this investment and the incoming and outgoing flows are synthesized in

594

“Ovidius” University Annals, Economic Sciences Series

Volume XVII, Issue 2 /2017

- thousands of lei -

Discounted cash-flow

Year

Option A Option B

Initial cost -3500000 -3500000

1 1500000 1475000

2 1800000 1680000

3 2000000 1500000

4 1150000 +930000 1450000 + 930000

Source: own calculations

The negative value represents the costs of the initial investment and the flows in year 4 are

cumulated with the residual value of the company at the time, 930000 thousands of lei.

In the following lines we shall answer the question: “Which of the two projects should be

chosen using the project selection method PP?”

For the purpose of determining the PP of the investments there must be determined the

cumulated discounted cash-flows for the two options. (Figure 2)

-thousands of lei-

Cumulated cash-flow

Year Opt. A Opt. B

Initial costs -3500000 -3500000

1 -2000000 -2025000

2 - 200000 - 345000

3 1800000 1155000

4 3880000 3535000

Source: own calculations

Substantiating the decision in financial management is realized after computing the payback

period for each project:

Project A:

The 3500000 thousands of lei initially invested are paid back in two years plus a period of t1

days that we shall determine. In the third year we recuperate 1800000 thousands of lei. We

calculate the daily cash flow for year 3.

2 000 000

CF3 / zi = 5 479 , 45 thousands of lei / day

365

The 200000 thousands of lei that remain at the end of year 2, will be recuperated in:

200 000 lei

t1 = = 36 ,5 days ≈ 37 days

5 479 , 45 lei / day

For project A it results a payback period of:

PBP = 2 years & 37 days.

Project B:

After 2 years, the initial investment is not fully covered. Again, we calculate the daily cash flow

for year 3:

1 500 000

CF3 / zi = 4 109 , 58 thousands of lei / day

365

The 345.000 thousands of lei that remain unpaid at the end of year 2.

595

“Ovidius” University Annals, Economic Sciences Series

Volume XVII, Issue 2 /2017

t2 = = 83 , 95 zile ≈ 84 zile

4109 , 58 lei / zi

PBP = 2 years and 84 days.

We choise project A for implementation. Project A is the one that proves again as being more

effective for the company.

The financial flows generated by implementing an investment project are produced at different

moments in time. In order to determine the profitability of an investment, we must compare the

financial flows, at the same moment, a process realized taking into account the TVM. This may be

accomplished through the discounting procedure by which all the generated flows of the

investment are mathematically translated to the initial moment of implementation of the project.

The method used in selecting the profitable project is the Net Present Value (NPV).

If we have several projects that have positive NVP, we will implement the one with the greater

net present value. If the NVPs are close, we will choose the project requiring a smaller initial

investment.

For the calculation of NVP we have the formula:

NPV = Net discounted cash flows - initial investment

and

n

CFi CF1 CF2 CFn

Vnetpresent = ∑ = + + ........ +

i =1 (1 + k ) (1 + k ) (1 + k ) (1 + k ) n

i 1 2

Thus, the NVP method does not offer decision makers any certain information regarding the

order of acceptance for financing various analyzed investment projects, it only answers the

question: “Are the projects acceptable?”.

We must decide, by using the NPV method, if the following project is profitable taking into

account the data:

Initial investment costs = 100000 EUR; Cash flow in the next 4 years: Year 1: 60000 EUR;

Year 2: 80000 EUR; Year 3: 80000 EUR; Year 4: 100000 EUR. Discount rate: 12%.

We discount the estimated cash flows and we compare them with the prior computed costs of

the investment. (Fig 3)

Discounted rate Discounted

Year Cash flow

(1+k)i cash flow

1 60000 0.8928 53568

2 80000 0.7972 63776

3 80000 0.7118 56944

4 100000 0.6355 63550

TOTAL: 237838

Initial investment: 100000

Source: own calculations

NPV = 237838 EUR - 100000 EUR = 137838 EUR > 0, the project is profitable and may be

implemented.

596

“Ovidius” University Annals, Economic Sciences Series

Volume XVII, Issue 2 /2017

4. Conclusions

TVM concept stands at the basis of the profitability analyses in financial management. As the

PP represents the period at the end of which the initial investment equals that of the total cash flow

generated by the investment project, we may say that this method is connected to the notion of

investment liquidity. The investment liquidity is greater as the payback period is shorter.

Discounting, as a financial technique, allows the comparison of the revenue obtained at different

moments in time with the initial costs necessary for the implementation of an investment. This

technique is useful in determining the profitable projects, as it was presented in the case study no 2.

Damodaran sed: ,,Present value remains one of the simplest and most powerful techniques in

finance, providing a wide range of applications in both personal and business decisions. Cash flow

can be moved back to present value terms by discounting and moved forward by compounding.

The discount rate at which the discounting and compounding are done reflect three factors: (1) the

preference for current consumption, (2) expected inflation and (3) the uncertainty associated with

the cash flows being discounted”. (Damodaran, 2016).

5. References

• Chen J. K, Time Value Of Money And Its Applications In Corporate Finance: A Technical Note On

Linking Relationships Between Formulas, American Journal of Business Education – September

2009, Volume 2, Number 6, p.77

• Damodaran, A., A Primer on the Time Value of

Money http://pages.stern.nyu.edu/~adamodar/New_Home_Page/PVPrimer/pvprimer.htm (accessed

10.12.2017)

• Kuhlemeyer G. A., Fundamentals of Financial Management, 12/e, Chapter 3, Time Value of Money,

© Pearson Education Limited 2008, wps.pearsoned.co.uk/wps/media/objects/.../VW13E-03.pptx,

(accessed 28.11.2017)

• Paniego MP, Muñoz MLM, International Banking Regulation: the Basel Accords and EU

implementation of Basel III, 2015, g. 4, eprints.ucm.es (accessed 28.11.2017)

597

- Groupe Ariel S.A. Case StudyUploaded byDavyDujardin
- Cost Engineering_ Time Value of Money - Chemical EngineeringUploaded byayyagarisri
- Chemical Process DesignUploaded byAudrey Patrick Kalla
- Biotech Valuation ModelUploaded byMichel Kropf
- Aurora SupplyUploaded byNabab Shirajuddoula
- Financial Management Case StudyUploaded byAin Nadia
- Chapter 8 Costing PDFUploaded byNurul A'ashikhin
- 3500145 Financial Math for Actuary and BusinessmanUploaded byavcy
- Corp. Finance Ksi FinalUploaded byxfiles64
- 3003308MS Sample Ms - AdvancedUploaded byJess@Doraemon
- Assignment1 SolutionUploaded byAnonymous dpWU6H5Lx2
- OceanCarriers KenUploaded bysaaaruuu
- Discounted Cash Flow Additional NotesUploaded bymetalee
- Aurora FinalUploaded byGuodong Huang
- Theory on Mafa CA FinalUploaded bySumit Kumar
- Mba Fam Assignment UogUploaded bykidszalor1412
- Multilateral Well Assignment.docxUploaded byAgung Sandi Agustina
- AnswerUploaded byMichael Kwatia
- Cost ModuleUploaded byJamroze Khan
- Avik's Dream ProjectUploaded byAvik Maitra
- CFTP Case Study 2012Uploaded bysyddraz
- PROBLEM 20-4.docxUploaded byRohail Khan Niazi
- NPVUploaded byMoonmoon Kazi
- CbaUploaded byIrsyad Khir
- psa backup 1 031108Uploaded byGreg aymond
- Chapters 8 - 10 - 11- 12 Questions.docxUploaded byJamie N Clint Brendle
- Fin S8Uploaded byM Yasir Ali
- Fes Ibility 01Uploaded byaichaanalyst4456
- Jbptunikompp Gdl Hermanssoe 25652 3 Kuliah0Uploaded byCecep Kurnia Sastradipraja
- Ch1 Intro Me Sem2Uploaded byAnnur Izzah Abdul Razak

- 17233rtp Ipcc Nov09 Paper7bUploaded byRobert Paredes Dimapilis
- Capital, And Other Stores of ValueUploaded byLucas Queiroz
- Solution Manual for Operations Management 9th Edition by KrajewskiUploaded byLakmal Himbutugoda
- Borrowed FundsUploaded byKarthik Rednam
- Income Tax Rates for the Past 10 YearsUploaded byTarang Doshi
- Homework 4 SolutionsISE460Uploaded byWill Price
- Midterm Exam Review FNCE 254Uploaded byphoebec-2
- 행복을찾아서 대본Uploaded bySang Hwa Lee
- Mahmood Textile MillsUploaded byParas Rawat
- 34922bos24617cp1-2Uploaded byPiyal Hossain
- Sport marketingUploaded byAnusorn Panich
- International Business Paper Oct 2009Uploaded byrksp99999
- Standard BankUploaded bySohaib Ahmad Khalil
- Web China Pak Golf Estates UK NEW2019Uploaded byPmu Res
- ifrs25122.pdfUploaded byAmit Kemani
- Brand ManagementUploaded byMukesh Kumar
- 0976279444.TallLdyUploaded byFrançois-Laurent Contenay
- Exercises Budgeting ACCT2105 3s2010Uploaded byHanh Bui
- CH_09_Inventories Additional Valuation IssuesUploaded byJoseph Gaspard
- Contribution of Banks in the Development of Indian SocietyUploaded byKarthikeyan Vicky
- NBP m.rasoolUploaded byMRasul Salafi
- HDFC Housing Opportunities Fund NFO Leaflet 1 Nov 2017Uploaded bykeval patel
- assets liabilities managmentUploaded bypriyank shah
- Elements of a Business PlanUploaded bywhoisme2000
- Stock Price Volatility and Dividend Policy in PakistanUploaded byIJSRP ORG
- Burma -- A Failed State Compared to NeighboursUploaded bymsoe9872
- Mrunal RBI Assistants 2014 Exam_ List of Questions & CutoffsUploaded byman3388
- Macro OoUploaded byAitana
- Dipali_Navrangpura.xlsUploaded byparthpvtltd
- 3 2018-12-05 Pltf Mem ISO PetitionUploaded bydanielrestored